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The Constitutional Crisis at the Fed

Throughout its history, the U.S. Federal Reserve has faced accusations, on the left and the right, that it is the mere institutional puppet of powerful bankers who control it from within. Marriner Eccles, the liberal Fed chairman during the 1930s and 40s, called it the “instrument by which private interests alone could be served.” Ron Paul, the former Republican Texas congressman, writes that through the Fed “our money and credit are constantly manipulated for the benefit of a privileged class.”

Today, because President Obama and, to a lesser extent, Senate Republicans have mismanaged the appointments to the Fed’s governing board, these views have become harder to dismiss. Under the Obama administration, for the first time in its history, Federal Reserve Bank presidents—essentially private bankers—have held a majority of votes on the Federal Open Market Committee (FOMC), the arm of the Fed that sets interest rates. In other words, by legal structure, private bankers, and not public appointees, can dictate U.S. monetary policy from the inside.

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The debate over private control of public money is nearly as old as the republic itself, dating back to the days of Alexander Hamilton, who built America’s first attempt at a central bank, and Andrew Jackson, who dismantled the second. By 1913, at the founding of Federal Reserve System, two rival views had emerged of what a modern central banking system should be. Some Democrats wanted a system in public hands—that is, a government-controlled central bank that could not be a front for the “Money Trust” dominated by New York City bankers. But Republicans almost uniformly argued that a government-run system was tantamount to socialism. They preferred a private-run system, based in New York, over which the government would have essentially zero control. Woodrow Wilson’s election in 1912 led the way to a compromise that put most monetary policy decisions in the hands of 12 privately run Federal Reserve Banks—all but one located outside of New York City—but subject to mostly ill-defined supervision by a government-controlled Federal Reserve Board based in Washington, D.C.

This Wilsonian compromise produced a failed experiment in central banking. In the absence of statutory clarity, personalities clashed within the system as Reserve Bank presidents fought each other and against the Fed board for dominance. In 1935, at the Roosevelt administration’s insistence, Congress abolished the old system and replaced it with one where the private bankers would wield significantly less power. In fact, the administration’s proposal originally eliminated the bankers from the business of monetary policy entirely. President Roosevelt’s proposal created an FOMC of purely public appointees, all based in Washington. But the bankers’ supporters in Congress pushed back and preserved a minority status on the FOMC. The new design would give the committee 12 spots, with seven for presidentially appointed, Senate-confirmed members of a new Board of Governors and only five to represent the private Federal Reserve Banks.

This seven-to-five public majority is the source of the FOMC’s democratic legitimacy today. It’s also key to the constitutional integrity of the Fed as a whole. Under a recent Supreme Court precedent, the FOMC structure almost certainly couldn’t pass constitutional muster; its only potential saving grace is the governors’ numerical majority.

For decades, the public majority held strong. From Truman to Ford, under presidents and Senate majorities of both parties, vacancies on the Board of Governors were filled promptly, as they became open. In fact, the governors lost their majority on the FOMC for just 16 days over the course of 32 years.

But after declining slightly in the 1980s and more in the 1990s, that majority has become increasingly fragile. Under the five years of the Obama administration, the public majority has held just 42 percent of the time, according to my calculations.

It gets worse. There are now only four sitting governors out of the required seven: Janet Yellen (the chair), Jerome Powell, Jeremy Stein and Daniel Tarullo. Powell’s term has in fact already expired, though the administration has nominated him for another term, along with two new potential members. Stein has just announced his resignation effective May 28. So if May 28 arrives without the confirmation of these pending nominees, there will be just two governors serving within their appointed terms.

Since the FOMC’s modern creation in 1935, there have never been five vacancies at one time. Until now, there had never been four vacancies. And there have been three vacancies just three times in history—all of which have occurred during the Obama administration. The Reserve Banks’ representatives can now, if they act in concert, take control of the nation’s monetary policy. The public has no say on their appointment. Neither does the president. Nor the Senate.

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Peter Conti-Brown is non-resident academic fellow at Stanford Law School and Ph.D. candidate in financial history at Princeton University. He is author of the book The Structure of Federal Reserve Independence, forthcoming in 2015.